What is your experience with CPI in retirement?

[67walkon]

The 3% inflation assumption has always seemed high to me. The biggest component to calculating CPI is house, making up over 40% of the CPI. It looks at housing expense, not prices or values, but most people have mortgages or rent.

If you own your house and don't have a mortgage, is 3% still the right number? Actually, a better question might be what the CPI looks like if you exclude rising rents, mortgage payments, etc. I realize taxes can rise, insurance can rise, utilities can go up, etc., but I wonder how much of the 40+% in the housing component of the CPI is rent or mortgage payments?

Does anyone "in retirement" for a few years, and with no mortgage or rent, have any thoughs on whether 3% is high, low or about right? And I always thought old people ate less!

 

[Nords]

You've revived a perpetual debate with no conclusive answers.

The best approach is probably to look at your own spending, decide what's affected by inflation, and either apply your actual data or 3%/year. That 3%/year is based on Dimson & Marsh's "Triumph of the Optimists" research of the last century of inflation across over a dozen countries. If your outlook is especially bearish then you could use 5%, which reflects roughly the 1970-2000 era.

Otherwise the debate usually goes along these lines:
- the CPI is manipulated by the government's "Plunge Protection Team" so it's useless.
- the CPI is manipulated by Social Security, Medicare, the Department of the Treasury, the Federal Reserve, and the Department of Defense so it's useless.
- the CPI's "hedonic adjustment" changes the standard too frequently for the index to remain consistent & relevant. You can't replace prime rib with hot dogs.
- the CPI doesn't reflect the personal spending of most Americans, only the broad aggregate.
- the CPI doesn't matter, because as soon as an expense category starts to skyrocket, consumers will stop paying for it.
and finally, my personal favorite,
- which CPI? The CPI-U, the CPI-W, or the [insert seasonally-adjusted special CPI variation here]?

 

[REWahoo]

Yes, he accuracy and validity of the CPI has been the subject of several discussions. Here is a link to more than three dozen CPI threads: http://www.early-retirement.org/for...-index-cpi-and-its-validity-or-not-30742.html

 

[traineeinvestor]

Ignoring the debate on whether CPI is or is not an accurate measure of inflation (and the fact that, technically, inflation is about the money supply), it really depends on your personal expenses. At best CPI is based on a basket of goods and services available to consumers. Since not everyone (probably nobody) will allocate their spending to the same basket in the same proportions and different people will have different spending habits, it follows that we would expect the average consumer to experience a personal rate of inflation which is either higher or lower than CPI itself.

We track our expenses with a reasonable degree of accuracy and for the last few years our costs have risen much more than CPI with the biggest $$ contributors being:

1. school fees
2. air tickets and hotels

Food, utilities and entertainment have also gone up noticably in the last 12-18 months.

Since we own our own place and mortgage interest rates remain very low (thank you Uncle Ben!), our housing cost has not changed for the last 2-3 years.

Post retirement, medical insurance is also going to be a concern.

 

[plex]

The picture is not rosy for personal inflation for anyone planning on living expenses of more than 400% of the poverty level for their family size, or medicare/medicaid, post 2014. This will actually only a large minority of the population, but for them, they can expect a personal inflation rate greatly exceeding 3%. Currently only a large minority of people have experienced this form of inflation because of employer-based plans, but that will change, and already has been changing due to employers simply not being able to handle the drastic increase in costs. It is certainly a large enough pool of people though that it is worth mentioning, especially for those early retiring, as it will likely be the greatest cause for personal inflation, if applicable.

 

[walkinwood]

I agree with the suggestions to track your own spending.

Our spending has remained essentially flat for the past 3 years (2008-10). But part of the reason was a concerted effort to keep our expenses low in reaction to our portfolio losses.

Our two largest inflationary increases have been health care premiums (15%/yr) and property taxes (+4%).

I have found it impossible nail my personal inflation rate & we have been tracking expenses for 7 years now. What expenses are affected by inflation and what are affected by fluctuation in use/demand? For e.g. you don't drive the same number of miles each year - especially in retirement. Some years you may not spend much in a category - say home repair or clothing - and then the next year, you end up spending a lot. When you travel a lot, your utilities & grocery bill may be lower. Your tastes change year to year.. and on & on.

 

[Nords]

Your tastes change year to year.. and on & on.

In other words inflation may be a minor effect and a major distraction...

 

[GeoffC]

CPI bias

There is a very useful website called Shadowstats that examines how the CPI is calculated and hot it changes in time. I have been examining this issue for quite some time--how to deal with inflation in planning. My conclusions:

1) The CPI is manipulated by the gov't in ways that make inflation seem low
2) Inflation is partly personal, partly macro
3) The best available inflation hedge is a fixed rate mortgage--you pay it back in inflated dollars
4) Personal inflation rates are tricky to estimate

I really quite like the Financial Integrity / YMOYL concept, but their assertion that you don't need to worry about the macro inflation rate is worrisome. When my health insurance goes up by double digit percentages every year, I need to worry about inflation.

 

[Midpack]

Can we talk about something less controversial like UFO sightings? Sorry...

 

[MichaelB]

The 3% inflation assumption has always seemed high to me. The biggest component to calculating CPI is house, making up over 40% of the CPI. It looks at housing expense, not prices or values, but most people have mortgages or rent.

If you own your house and don't have a mortgage, is 3% still the right number? Actually, a better question might be what the CPI looks like if you exclude rising rents, mortgage payments, etc. I realize taxes can rise, insurance can rise, utilities can go up, etc., but I wonder how much of the 40+% in the housing component of the CPI is rent or mortgage payments?

Does anyone "in retirement" for a few years, and with no mortgage or rent, have any thoughs on whether 3% is high, low or about right? And I always thought old people ate less!

Much depends on your lifestyle and ability to substitute. Healthcare insurance plus healthcare costs are by far our single highest expense category and costs are rising double digit for at least the past 5 years, high single digit for the 10 years we are FIREd. Most other expenses are more easily controlled.

Healthcare - insurance plus expenses - is by far the biggest expense we

 

[brewer12345]

Can we talk about something less controversial like UFO sightings? Sorry...

They fit right in with the CPI manipulation discussion.

 

[East Texas]

You've revived a perpetual debate with no conclusive answers.

The best approach is probably to look at your own spending, decide what's affected by inflation, and either apply your actual data or 3%/year. That 3%/year is based on Dimson & Marsh's "Triumph of the Optimists" research of the last century of inflation across over a dozen countries. If your outlook is especially bearish then you could use 5%, which reflects roughly the 1970-2000 era.

Otherwise the debate usually goes along these lines:
- the CPI is manipulated by the government's "Plunge Protection Team" so it's useless.
- the CPI is manipulated by Social Security, Medicare, the Department of the Treasury, the Federal Reserve, and the Department of Defense so it's useless.
- the CPI's "hedonic adjustment" changes the standard too frequently for the index to remain consistent & relevant. You can't replace prime rib with hot dogs.
- the CPI doesn't reflect the personal spending of most Americans, only the broad aggregate.
- the CPI doesn't matter, because as soon as an expense category starts to skyrocket, consumers will stop paying for it.
and finally, my personal favorite,
- which CPI? The CPI-U, the CPI-W, or the [insert seasonally-adjusted special CPI variation here]?

Excellent observations. The line item in red was almost a month long discussion in graduate economics.

 

[friar1610]

Without getting into the technicalities of the various CPI's, this has been my experience:

- I started real retirement from the baseline of a Navy pension in 1996. (I was 58 at the time; I'm 65 now.)
- I had budgeted withdrawals from my portfolio of $2K per month to supplement that.
- Over time, I realized that I only rarely needed to tap the portfolio. (Until the last couple of years, of course, the pension got an inflation adjustment each year.)
- I've been drawing SS for almost 3 years now and my wife has for about a year an a half. We rarely need the SS money. We use it approximately as much as we tapped the portfolio in the pre-SS years.

So.... on one hand, inflation has not been a big issue with us in how we live. On the other hand, I've been blessed with inflation adjustments for most of the time I've been drawing the Navy pension.

I find that I increasingly find ways to trim expenses on things that aren't that important to me while not hesitating to spend on things that are. (Example: I spend virtually nothing on clothes now. But because I spend a fair amount of time hiking, running and working out, I don't scrimp on high quality shoes.)